UBS’ $2.4 million autocalls with daily knock-in reward investors for added risk, sources say

By Emma Trincal

New York, Oct. 18 – UBS AG, London Branch’s $2.4 million of trigger autocallable contingent yield notes with daily close monitoring knock-in due Jan. 16, 2025 linked to the worst performing of the Nasdaq-100 index, the Russell 2000 index and the VanEck Gold Miners ETF present risks due to the worst-of and barrier style, sources said. But the sizes of the contingent protection and coupon rate appeared to fairly compensate investors for the risk, sources said.

The notes will pay a contingent monthly coupon at an annual rate of 17% if each underlier’s closing level is at least 65% of its initial level on the corresponding observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par plus the coupon if each underlier closes at or above its 105% call level on any monthly valuation date after six months.

If the notes have not been called, the payout at maturity will be par unless any underlier closes below its 65% knock-in level during the life of the notes and any underlier finishes below its initial level, in which case investors will lose 1% for every 1% that the worst performer finishes below its initial level.

UBS Financial Services Inc. and UBS Investment Bank are the agents.

Low correlations

“It’s pretty short-term. The underlying assets are loosely correlated so you can increase the coupon,” said a structurer.

“But they’re not negatively correlated.”

The one-year correlation between the Russell 2000 index and the Nasdaq is 80%; it is 17% between the Russell and the VanEck Gold Miners ETF; and 21% between the Nasdaq-100 index and the gold miners ETF.

“These are low correlations but it’s sometimes tricky because you’re talking historical, not implied correlations,” he said.

Autocall control

“Using a worst-of will increase the coupon notably, and it’s true that low correlations help pricing. But you can’t really determine by how much without running a pricing model,” he said.

This structurer said that he sometimes adds a less correlated underlier in a worst-of not to increase the odds of a barrier breach but to reduce the likelihood of an autocall.

“We’ve done a note on the Nasdaq and the Euro Stoxx. I added the FTSE 100 to the mix. The FTSE 100 is not volatile enough to breach the barrier. But the correlations are low enough to prevent the autocall,” he said.

Range band

Investors in the notes are yield-seekers willing to take some risk based on a sanguine view of the market, he said.

“65% is a deep barrier. If you don’t think we’re going to have a recession or that the market is going to crash, you’re getting handsomely rewarded with the 17% coupon,” he noted.

The confidence required to buy the notes relies in part on monetary policy expectations.

“If the Fed keeps interest rates about 0.5% higher or lower in the next 18 months, the market may ramble along and you could see it moving up or down in the 10% to 15% range, not 35%,” he said.

American barrier

The significant risk factor in the structure was the so-called “American barrier,” he said.

The term comes from the – “American” option style – a type of option that can be exercised at any time during the length of the contract. In contrast, European options are exercised at the expiration date, which is the maturity date for a note.

Almost all structured notes are constructed on European barrier options.

“If you can breach any day, you significantly augment the risk, so this is definitely going to give you better optics,” he said.

Improved terms

The American style allowed the issuer to lower the barrier by at least 10 percentage points, he said, meaning that that the equivalent note created on a European option would have shown a 75% barrier at maturity.

But the most sought-after enhancement was the coupon, he added.

“This daily knock-in is going to give you at least 5% more in coupon compared to a European barrier,” he said.

In other words, the same note with a European barrier would yield approximately 12% per annum.

“You’re definitely improving the terms,” he said.

Nasdaq in focus

Tom Balcom, founder of 1650 Wealth Management, said the notes could be used in an aggressive portfolio.

“It is risky, perhaps a bit too risky for my liking. But you get compensated for that,” he said.

The equivalent risk-free rate is approximately 5.5%, he noted, which means that noteholders are getting a 11.5% premium over Treasuries.

Some of the underlying assets showed less risk than others based on their valuations, he said.

“The Russell had a big pullback. So, this one makes me feel a bit more comfortable,” he added.

The small-cap benchmark is trading 14% off its February high.

Separately, the VanEck Gold Miners ETF has dropped 19% from its one-year high of May.

He said that only the Nasdaq-100 index was still overvalued.

“The Nasdaq is near its peak and has skyrocketed since last fall. It’s the Nasdaq I would be concerned about, not so much the other two,” he said.

The tech-heavy index has jumped more than 40% from its early November low.

Balcom also liked the autocall structure, which combines a higher call trigger at 105% and a six-month no-call.

“Both features, especially the 105-call threshold, are a cushion against reinvestment risk. I like it a lot. You want to hold the notes to maturity in order to get the maximum return,” he said.

Size matters

But with the absence of a call comes the increased market risk due to the American barrier.

“It’s obviously a bit risky if you can hit the barrier any time. At the same time, I’m very comfortable with the 35% protection. The larger the barrier, the better,” he said.

Balcom said the size of the barrier made it a “conservative cushion,” especially when two of the underliers offered attractive entry points.

The same couldn’t be said of the Nasdaq, he conceded.

“But tech stocks are stocks of companies everybody uses every day. This is an index that’s in every 401K. I’m concerned about a correction, but I don’t think it could drop as much as 35%,” he said.

He concluded that the note was “not for everyone” but that it could add value to a portfolio.

“It’s an aggressive play. But the risk-reward is fair. You’re getting fairly compensated if you’re willing to take that type of risk,” he said.

The day before, BofA Finance LLC priced nearly the same deal for $1 million. The only differences were the coupon rate of 17.25% and a 1% fee versus 0.25% for the UBS offering.

The UBS notes (Cusip: 90279WJV7) settled on Monday and priced on Oct. 11.

The BofA Finance notes (Cusip: 09711AVS4) settled on Oct. 12. The notes are guaranteed by Bank of America Corp.

The agent is BofA.

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